on Signs of "Demand Destruction"

• Topline ISM Manufacturing Report index fell sharply in June 2022, down 3.1 index points to 53.0
• The New Orders component index fell into contractionary territory (<50) for the first time since the pandemic’s early months
• Supplier Deliveries also saw a significant decline in June 2022, falling to 57.3 – a level not seen since mid-2020
• The Backlog of Orders component index eased in June 2022, providing further indication that “Demand Destruction” could be taking hold

The ISM Manufacturing Report saw a significant decline in June 2022, down to 53.0 from 56.1 in May. This month’s drop is the largest single-month decline since the pandemic’s initial impact on the report (-8 index points in April 2020). The details of the ISM Manufacturing Report suggest that “Demand Destruction” may be taking shape.

The Federal Reserve is doing its job in attempting to slow economic activity in their fight against inflation. One of their talking points is that tighter monetary policy can induce a slowdown in demand, which in turn will relieve some of the upward pressure on consumer price growth. From a glimpse of improving Customer Inventories to indications that manufacturers’ future demand is easing, the June 2022 ISM Manufacturing Report could be the first sign of progress on the “Demand Destruction” front.

Although still elevated, Commodity Prices faced by manufacturers eased for a third consecutive month in June 2022. This component index fell to 78.5 from 82.2 in May, and is now down from 87.1 in March. Keeping the breakeven threshold of an index level of 50.0 in mind, Commodity Prices clearly continue to provide a source of stress on manufacturers. But with New Orders for June 2022 in contractionary territory (49.2) and Customer Inventories ticking up (35.2, from 32.7 in May), early signs of relief on upstream pricing pressures seem to be emerging. Prices paid by manufacturers inevitably add to consumer costs as they are passed on by both wholesalers, transportation intermediaries, and retailers.

And so before consumer price growth can hope to stabilize, producers’ own costs must settle. The June 2022 ISM Manufacturing Report suggests that both the supply and demand sides of the manufacturing sector are on the right track toward that result.

The ISM Manufacturing Report’s Employment component index for June 2022 came in at 47.3. This result is the second consecutive month below the breakeven threshold of 50, suggesting that a demand for labor in the sector is easing. Coupling this result with a contractionary New Orders result in this month’s report (49.2), and that the New Orders index is down from a high in February 2022 of 61.7, manufacturers seem to no longer be faced with dire shortages of workers, but rather have some breathing room to hire less in the face of easing demand.

Again, “Demand Destruction” is a significant buzzword worthy of ingraining in the inflation and overall economic activity conversation, as inflation pressures have been sustained by still-ample consumer demand chasing limited supply of virtually all products and services. If this month’s ISM Manufacturing Report is the start of a trend, the Federal Reserve’s early aggressiveness in tightening monetary policy could help achieve its targeted “soft landing” by preventing significant overextension by households looking to maintain spending habits despite rapidly rising prices.

One of the contributors to concerns over U.S. GDP Growth is that the U.S. trade balance between imports and exports will be a detractor, with imports rising more rapidly than exports. The June 2022 ISM Manufacturing Report providing some evidence of a move in this direction. The Imports component index rose to 50.7, up from a short-lived dip into contractionary territory in May (48.7). The Exports component index dropped for June 2022, also to 50.7 – but in its case down from 52.9 in May. Central banks across the globe are tightening monetary policy, which will have similar dampening effects on consumer and business demand in those economies.

If U.S. manufacturers’ exports weaken further, the drag on overall GDP will indeed increase the potential for topline GDP declines. The ISM Manufacturing Report will provide early insights into those prospects, as well as the contribution of inventories to GDP growth, in the coming months.

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